Investing for Retirement: A How-To Guide
Does the idea of figuring out how to invest your retirement savings give you a sense of anxiety and overwhelm? Heartburn, even? We’ve got just the remedy for you.
Two remedies, in fact. The first one is an ultra-simple approach that takes care of all of your retirement investing in one fell swoop. We literally mean one, as in a single investment that takes care of this entire how-do-I-invest-for-retirement business.
The second remedy is also simple, but a little more hands-on. It’s the perfect investing plan for you if you prefer a slightly more hands-on, DIY approach.
In this article, we’ll talk about two ways to invest for retirement and the pros and cons of each approach. But first, an important public service announcement.
A word about buy-and-hold investing
The two investment ideas presented here are what’s called passive, buy-and-hold investing. You pick your investments, you invest your money, you let it sit there for the long haul.
With buy-and-hold investing, generally the only tinkering you need to do with your investments after you create your portfolio is to rebalance, which means moving money between your investments to make sure the percentages invested in stocks and bonds continue to match your desired asset allocation. (Read about what asset allocation is and why it matters.)
Rebalancing is important for two reasons:
- First, the market’s gyrations will bump around the percentage allocations in your portfolio — your stock holdings may gain value, for example, and thus become a bigger percentage of your portfolio — so occasionally you may need to reset your percentages back to your original plan. (With the target-date mutual funds described below, a pro money manager will handle this rebalancing for you.)
- Second, as your goal for spending this money approaches, it’s important to shift out of riskier investments such as stocks. That means selling your shares and putting the money in some sort of cash-type account, such as short-term bonds or a bank savings account. That’s because you don’t want to find yourself needing to sell your stock shares when the market’s down. It’s important to check in with your investment plan with your time horizon in mind, and make moves as your goal nears fruition.
1. The ultra-simple approach: a target-date fund
Target-date funds were created to be a one-stop-shop investing product for people saving for retirement. Many workplace retirement plans such as 401(k)s offer access to these set-it-and-forget-it funds.
If you don’t have a retirement plan at work, you can open a traditional or Roth IRA at a broker and invest in a target-date fund yourself. (Find the best brokers for IRAs on our sister site StockBrokers.com.)
A target-date fund (also called a lifecycle fund) is a mutual fund that invests in other mutual funds to provide a highly diversified investment portfolio that is managed for you over the course of your working life and even into retirement. (A mutual fund is a type of investment where investors pool their money to buy shares of stocks or bonds; some mutual funds invest in hundreds or even thousands of companies.)
Finding the right target-date fund for you is as simple as picking the one that’s titled with the year you plan to retire (see some examples below). And it’s fine if you don’t know when you’re going to retire; simply pick the target-date fund with the year closest to, say, your mid-60s.
Some target-date fund caveats
As with any investment, there are some details to consider when investing in target-date funds.
- Target-date fund caveat: An added fee
Most mutual funds charge fees called expense ratios (essentially a management fee). With a target-date fund, generally the fund is investing in other mutual funds, and usually you’ll pay the expense ratios of those underlying mutual funds plus an expense ratio for the manager of the target-date fund.
In other words, a target-date fund is going to be a little bit more expensive than if you created your own investment portfolio. Of course, they do say time is money, and the DIY approach will take a little bit more of your time, so there’s that.
If you’re investing through a workplace plan like a 401(k), you’ll simply have access to whatever target-date funds are offered by the plan and you won’t be able to shop around on fees. (It still can be a good idea to invest in your workplace plan. Here are tips on finding the best retirement plan for you.) But if you’re going to invest in a target-date fund through your own IRA, then shop around. As an example, here’s a fee comparison of three target-date funds:
|Target date fund||Expense ratio||In plain English|
|Fidelity Freedom 2055 Fund||0.75%||$7.50 for every $1,000 you invest||T. Rowe Price Retirement 2055 Fund||0.64%||$6.40 for every $1,000 you invest||Vanguard Target Retirement 2055 Fund||0.08%||$0.80 cents for every $1,000 you invest|
Those fees may not seem all that different, but fees matter, people. They add up over time — did we mention that expense ratios are an ongoing expense, not a one-time thing? — and eat away at your returns.
Consider this: If you invest in a mutual fund that charges a 0.50% fee instead of one that charges 0.25%, you’d have $10,000 less at the end of 20 years. If you paid a 1% fee instead of 0.25%, you’d be out almost $30,000 over 20 years. (This example assumes a 4% annual return.)
If you invest in a mutual fund that charges a 0.50% fee instead of one that charges 0.25%, you’d have $10,000 less at the end of 20 years.
- Target-date fund caveat: ‘To’ retirement vs. ‘through’ retirement
Some target-date funds invest to your retirement date — that is, they assume you’ll withdraw your money and stop investing around that date. But many target-date funds invest based on the assumption that you’ll stay with the fund through your retirement.
While the portfolio shifts to more conservative investments as your retirement date approaches, the fund may still be quite heavily invested in stocks because the fund manager expects you to keep your money in the fund during a retirement that could last 20 to 30 years.
This question may not matter much in your 20s, but once you’re getting closer to retirement, it makes sense to look closely at your target-date fund to see what the plan is for your invested money, and make sure it aligns with your goals.
- Target-date fund caveat: More time to retirement = more aggressive investments
If the thought of having your money 90% in stocks kinda freaks you out, then consider choosing a target-date fund with a shorter timeframe. The closer the target-date fund is to the retirement date, the more conservative it’s likely to be. Conversely, if you’re a fan of maximizing potential returns, then pick the furthest-out date you can — that’s likely to be the fund most heavily invested in stocks.
2. Next-level simple: a Lazy Portfolio
Lazy Portfolios are another simple, set-it-and-almost-forget-it way to invest for retirement. Each Lazy Portfolio is made up of a handful of index mutual funds or ETFs and you simply invest in exactly those same funds, or find very similar funds (for example, a total stock market index mutual fund). Then sit back and relax, more or less, until retirement.
These investment portfolios will be cheaper, generally, than a target-date fund, and you control what you’re investing in. But a lazy portfolio, even though it’s nice and lazy, does require a little more of your hands-on work than a target-date fund.
For one, you have to find the investments that match the portfolio (very easy through a brokerage account; more challenging if you’re investing in your workplace retirement plan, which will have fewer investment choices).
For two, you’re in charge of rebalancing when your asset allocation gets bumped around by market moves. On the plus side, a Lazy Portfolio is going to be one of the hands-down cheapest ways to invest for retirement.
Below are three well-known lazy portfolios. (To find out more about Lazy Portfolios, check out the Bogleheads, a community of buy-and-hold investors, named after John C. “Jack” Bogle, founder of Vanguard and creator of the index mutual fund.)
Note that some of these portfolios refer specifically to Vanguard index mutual funds or ETFs, but these days there are so many index mutual funds and ETFs, you can easily create these same portfolios with mutual funds or ETFs from other companies.
For example, Fidelity Investments, Charles Schwab and Vanguard Group all offer an index fund that tracks the S&P 500 index — all of these funds have “500 index fund” in their name. Similarly, many fund companies offer a total bond fund.
Any fund’s summary description will include the fund’s objective and strategy, e.g., “to track the performance of the S&P 500 index,” so be sure to read that if you’re not sure. (Google isn’t always your friend when researching mutual funds — search results don’t always include the fund’s description — so you might need to go directly to the fund company’s website to search for the fund.) Always be sure to look for the lowest-cost funds you can find.
William Bernstein’s No-Brainer Portfolio
William Bernstein is a well-known money manager (and neurologist!) who has written many books on investing. Here’s his Lazy Portfolio:
Divide your money evenly among these four index mutual funds:
- Vanguard 500 Index (VFINX)
- Vanguard Small-Cap Index (NAESX)
- Vanguard Total International Stock Index (VGTSX)
- Vanguard Total Bond Market Index (VBMFX)
Rick Ferri’s Two-Fund Portfolio
Rick Ferri, a money manager and author of many investing books, offers the simplest of lazy portfolios: You invest in one global stock market fund and one broadly diversified, investment-grade bond fund, such as Vanguard’s Total World Stock ETF (VT) and Total Bond Market ETF (BND).
Ferri doesn’t designate how much money you put in the stock fund vs. the bond fund, so you get to choose. You could go with an 80/20 portfolio (80% stocks and 20% bonds), a 60/40 one, a 20/80 one, or anything in between. It comes down to your tolerance for risk. Read our story on asset allocation for more info on how to make this decision.
Scott Burns’ Margaritaville Portfolio
Scott Burns is a longtime financial writer. His Margaritaville portfolio is equal parts of a total U.S. stock market fund, a total international stock market fund and a total U.S. bond fund. He also created the Couch Potato portfolio, which is equal parts a total U.S. stock fund and a total U.S. bond fund.
Some Lazy Portfolio caveats
As with option No. 1, there are some factors to consider.
- Lazy Portfolio caveat: You have to pick a Lazy Portfolio
There are a lot of Lazy Portfolios to choose from and for some people that can lead to decision paralysis. Real talk? The most important thing is to get started investing for retirement. Just pick a portfolio and go with it, and if you have second thoughts, then consider hiring a financial advisor, or shift your retirement savings over to a target-date fund.
For many of us, now that old-school pensions are pretty much a thing of the past, saving for retirement is on our shoulders, and the potential gains offered by the stock market could be the difference between a fun retirement and… something else. (Frankly, our take is that Social Security absolutely will be there for anyone currently in the workforce, but benefits may decrease and, even today, benefits aren’t necessarily enough to fund a super relaxing retirement.)
- Lazy Portfolio caveat: You have to find mutual funds that match a Lazy Portfolio
If you’re investing through an IRA or Roth IRA at a big-name brokerage such as Charles Schwab, Fidelity or Vanguard, you’ll have no problem finding the exact mutual funds and ETFs that match a Lazy Portfolio’s holdings. (Here’s a roundup of best brokers for IRAs on our sister site StockBrokers.com.)
That’s not so true if you’re investing through your retirement account at work. You absolutely want to get any matching funds your employer offers — that’s free money, after all! — but if the investment options aren’t great, then look for a target-date fund or the cheapest mutual fund you can find in your plan, contribute enough each paycheck to get your company match, and then also open a traditional or Roth IRA at a brokerage so you can build your own Lazy Portfolio there.
If you do end up with multiple retirement accounts, be sure to think of them holistically. Combined, those accounts comprise your investment portfolio and you want to make sure you’re as diversified as possible.
- Lazy Portfolio caveat: You’ll have to do the rebalancing
With a target-date fund, the fund manager makes sure that the target-date fund stays within its preset asset allocation. Not so if you take the Lazy Portfolio path. You’ll need to check in with your investment account at least once a year or so to make sure your 70/30 portfolio (70% stocks and 30% bonds) hasn’t turned into, say, an 83/17 portfolio.
The good news is: A shift like that means your stock holdings have gained in value. But it also means you’ll want to shift your portfolio so it gets back to your 70/30 allocation. You can do that by selling some equity holdings and increasing your bond holdings, or you can do it by directing more of any new money you put into the account into bonds.
Target-date fund vs. Lazy Portfolio: pros and cons
|Pros and cons||Target-date fund||Lazy portfolio|
|Pros||–Super simple and easy one-stop shop –Professional management includes rebalancing and shifting to more conservative allocation as retirement date approaches||–Ultra low cost
–Easy to set up
|Cons||–Even the cheapest target-date fund is likely to have an added fee to pay for the management of the fund, and thus will be more expensive than a Lazy Portfolio or a portfolio you put together yourself
–Buy-and-hold means watching account value rise and fall over time
|–Many Lazy Portfolios to choose from can make it hard to pick
–May be impossible to find “matching” investments in your workplace retirement plan
–Buy-and-hold means watching account value rise and fall over time
A note about robo-advisors
Maybe the thought of finding a target-date fund or building your own Lazy Portfolio is simply too much. You just want someone else to handle this whole mess. No problem. You can either hire a financial advisor who can manage or guide your retirement investing for you. (We’ve got some thoughts on how to find a financial advisor you can trust.)
Or, consider a robo-advisor. A robo-advisor is a type of financial advisory firm, but instead of you meeting one-on-one with a human, you go to the robo-advisor’s website, enter some information about your goals, fill out a questionnaire that measures your tolerance for risk, and then the robo-advisor suggests an investment portfolio that makes the most sense for your situation.
The thinking is: If you’re simply looking to invest for a particular goal, then, like most of us, you’re likely to be well-served by a fairly standard investment portfolio aligned with your risk tolerance. If you’re not sure where to start, consider some of the big-name brokers such as Fidelity Investments, Charles Schwab and Vanguard Group (reviews are on sister site StockBrokers.com) — they all offer a robo-advisor option.
And there you have it: another easy way to become an actual investor. Welcome to our world. Commence wealth-building.
Which investment is best for retirement?
The best investment for retirement will depend on you, but here are some great ones to get you started:
- A target-date fund. These are one-stop-shop mutual funds. You pick one target-date mutual fund based on the year you expect to retire. That’s it. You’re done. Get outside for a walk or a run. You are literally done investing for retirement (though we highly recommend making regular contributions to your retirement account).
- A handful of mutual funds in the form of a Lazy Portfolio. OK, for whatever reason you don’t like the idea of a target-date fund, and you’d rather take a slightly more hands-on approach. No problem. Lazy Portfolios are investment portfolios consisting of two or more mutual funds or ETFs. You simply pick a Lazy Portfolio to mimic (see some examples above), and then find the same or similar mutual funds or ETFs to invest in.
What is the 3% or 4% retirement rule?
The 3% and 4% retirement rules are different versions of the same idea, otherwise known as a safe withdrawal rate for your retirement savings. A safe withdrawal rate is the percentage of your retirement savings that you can withdraw each year while still having your money last through retirement.
The original theory is the 4% rule, which says that your money will last for about 30 years, with these assumptions: Your money is invested in a diversified portfolio of at least 50% stocks and the rest bonds, you withdraw 4% each year, and starting in the second year you increase your withdrawal rate to account for inflation. The original concept was based on a study that included the Great Depression and other market crashes — 4% was found to be the safe withdrawal rate for a long-lived portfolio.
That said, some people now say economic and market conditions suggest that 4% may be too high a withdrawal rate; they say 3% is a safer bet. In 2022, research firm Morningstar said 3.8% is a safe withdrawal rate, up from 3.1% in 2021. Read their State of Retirement Report 2022 for more information.
We have to go deeper
Dive further into the worlds of retirement and investing in our plain-English series.
- Retirement Accounts: What type of account should you use for your retirement savings? How much should you contribute? And what about taxes? This series will help you create your game plan.
- Investing 101: Investing can be an intimidating topic to come to cold, but our short course will walk you through how to set your goal and get started with stock trading.
How Much Should I Be Saving for Retirement?